Inside the Broker - Fed tapering and Non-Farm Payrolls

Inside the Broker

Fed tapering and Non-Farm Payrolls

September proved to be a difficult month for stock markets. After a decent start which saw the S&P 500 hit a fresh all-time high just under 4,550, the index fell sharply. The sell-off continued throughout the month before the S&P hit a low of 4,270 on 1st October for an overall loss of 6%. Both the Dow and NASDAQ followed similar trajectories. But that October low marked the end of the pull-back. The US indices went on to rally sharply, with the S&P rising 6.9% over the month, while the Dow and NASDAQ 100 rose 5.8% and 7.3% respectively.

October relief

This was good news for stock market bulls. October can prove to be a testing time for equities. In this century alone, the S&P 500 has posted October losses in 2004, 2005, 2007, 2008, 2012, 2014, 2016, 2018 and 2020. Going back further, October 1987 was a disastrous month to be long of stocks. That was when the S&P lost a third of its value in less than three weeks. So, given the history, together with murmurings that US stocks are extremely overvalued, there was a feeling of relief that last month saw the major indices not only recover their September losses, but go on to hit a succession of fresh record highs. This bullishness has been driven by a belief that the worst of the coronavirus pandemic is behind us, together with massive dollops of fiscal and monetary stimulus, topped off by a very strong third quarter earnings season. But what now?

Tapering announcement

On Wednesday the US Federal Reserve concluded a two-day rate setting meeting. Generally, little happens in November. But this time round there was an expectation that the central bank would announce details about tapering its $120 billion per month bond purchase programme. Investors weren’t disappointed. The Federal Open Market Committee said it would scale back its purchases by $15 billion per month starting in November, beginning a process that could be completed by mid-2022, although the Fed reserves the right to alter the programme should conditions change. This suggests that the flow of monetary stimulus, which has done so much to lift all risk assets, will begin to trend downwards rather than relentlessly upwards. If the bond purchases are being wound down, then surely rate hikes can’t be far away? While members of the Federal Reserve insist that rate hikes won’t automatically follow the taper, the markets put the chances of a hike by June next year at over 60%, according to the CME’s FedWatch tool. But investors are taking this in their stride, so far considering the US central bank’s taper to be a vote of confidence in the economy.

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Non-Farm Payrolls

The Federal Reserve decision isn’t the only big piece of market news this week. The latest Non-Farm Payroll update is released today. The expectation is that payrolls rose by 455,000 in October. If so, that would be well ahead of September’s dismal reading of 194,000 which was a long way short of the consensus forecast of 490,000. Now, on Wednesday we had a very positive ADP payroll number covering the private sector. This may be a harbinger of a strong official reading, although historically there’s been a low level of correlation between the two releases. The big question is how the market will react to the numbers. Will a strong reading boost market sentiment? Or will investors worry that the Fed may look to tighten monetary policy faster than expected to dampen down inflationary concerns? Alternatively, what happens if the number disappoints? That could be taken positively if it’s interpreted as delaying future rate rises. Alternatively, we could see equities sell off on fears that the economic recovery is faltering.

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